Simon Turner, of the Small Cap team, discusses some valuable investing lessons from his 4 year old daughter, as well as a number of stock and Small Cap portfolio examples. Parenthood provides a great opportunity to see where universal investment biases start from, and can provide valuable insight into behavioural finance in general.
Children Are Open Doors of Information
My parenthood journey is like anyone else’s; full of lessons, ups and downs, and massive life changes. One of the greatest opportunities parenthood has given me is a deeper insight into how humans tick in general, since unlike most adults my 4 year old daughter has absolutely no filter - I can constantly hear what she is really thinking, both good and bad. It’s a fascinating journey.
Whilst my daughter was talking to me recently, it struck me that I was having exactly the same conversation with her as I had been with an investment analyst earlier that day. Yes, the language was different but the sentiment was exactly the same. And this got me thinking about the lessons I can learn about investment biases from my daughter.
Here are my daughter’s top 5 investment lessons:
1. We only believe that something is of value if other people are seen to want it
My daughter is literally only interested in toys if they are of value to other children. It is fascinating watching a bunch of children playing and noticing that they all want to play with the toys that are already being played with, and conversely no one will go anywhere near the unwanted toys which are left lonely and lifeless on the side. That’s a description of inefficient financial markets right there – stocks which are in favour and with momentum behind them generally attract more investors who want a part of the action, whilst the illiquid under-performers are generally left on the sidelines.
In the Small Cap team, we watched in amazement as Australia’s leading technology stocks such as Altium (ALU), Afterpay (ASX:AFT) and Wisetech Global (ASX:WTC) increased exponentially through 2017 and 2018, whilst many high quality stocks with largely recurring revenues such as Elanor Investors (ASX:ENN) and Joyce Corp (ASX:JYC), both portfolio holdings, marked time. The difference between a stock with momentum and one without can be as simple as perception which influences the emotions stirred in the investment world – the same effect as a popular children’s toy versus an unpopular toy. The idea of scale-able technology solutions is generally viewed as exciting by the investment world whilst online auctions, beds and kitchens does not have the same allure. From our perspective, this is why investing in smaller companies is so exciting – because market inefficiencies can become extreme, which creates attractive opportunities.
Homework: Before you next invest in a stock ask yourself: am I making a totally independent investment decision here or am I being influenced by how popular this stock has been of late?
2. We all unknowingly seek confirmation of our own opinions which blinds us to reality
All parents get asked a lot of questions by their youngsters, usually starting with why. Interestingly. I have noticed that my daughter will often seek answers that confirm what she already knows or thought she knew. For example, she asked me recently if cats lick themselves in order to clean themselves – and she framed the question in a manner which allowed me to confirm that she was right.
Many of us do the same thing as investors. We are consciously or subconsciously more attuned to hearing thoughts which confirm our own view of the world, and tell us that we are right to think the way we do. Confirmation bias is arguably one of the most prevalent of the behavioural finance biases and one which takes real focus and discipline to become aware of. You’ll know when you’re starting to master this bias when you can comfortably spend time with people who have strongly opposing stock views to you and thus challenge the very core of your investment thesis.
Homework: Find people who have different views to your own on a range of investment issues including some of your existing investments. Ask them to explain their point of view, and genuinely listen. Can you calmly listen to their opinion or do you feel an emotional need to defend your viewpoint? You’ll either learn something new about the stock, or about yourself.
3. Your first loss is your best loss
It is remarkable how fast my daughter moves on when she has lost a toy. She recently lost “tiny bunny” which was her favourite toy up to that point. I thought she’s be upset for an eternity so I found an exact replica of “tiny bunny” which was only available in France of all places – I ended up ordering it and paying shipping costs which were higher than the value of the toy. However, whilst the new bunny was being shipped all around the world I discovered that she had already forgotten about “tiny bunny”, and now had moved on to a new best toy, “big ding”. Yes, it would have been good to know this earlier.
The investment lesson here that is your first loss is your best loss. This is a hard lesson to learn for most investors but the sooner you move on from your mistakes, the sooner you can move onto more successful ideas.
Homework: The next time you make a genuine investment mistake (i.e. when your investment thesis goes off track), move on as fast as you can to cut your losses.
4. The future may look different from the past
As a 4 year old, you have a limited amount of experience and knowledge with which to make sense of the world. What is fascinating to me is the way that despite her limited experience, my daughter forms habits very quickly and expects the future to accurately reflect her past experiences. For example, we often go out for breakfast to a local restaurant on the weekends. However, recently we decided to try a different restaurant and when we told my daughter about the change she seemed genuinely put out that we would change the plan, and provide her with a breakfast which did not match the picture she had in her head. We were entering the unknown and she clearly felt less comfortable with the idea.
Investing is very similar. We all try to make sense of the world based upon piecing together and trying to make sense of our own experiences. However, this means we are all trying to picture a future based upon what has happened in our own pasts. And one of the wonderfully humbling aspects of investing is that the future generally looks different from the past in ways that none of us are able to know or understand in advance. So it is worth remembering that the one thing that is certain is that the future will look different from the past.
Homework: Make a list of 5 investment beliefs you have for the year ahead. For each belief ask yourself why you think you know this, and whether you could in fact be wrong.
5. Hold onto your best stocks for the long term as they are gifts which keep on giving
My daughter has a very well developed internal ranking system of her toys which reflects a hierarchy of her conviction levels. She has 3 toys which out-rank all her other toys in her mind, and she keeps them close to her at all time, including when we go on holidays. Her next ranking level down is filled with around ten toys which she likes but feels less emotional about. And the bottom rung on the ranking system is filled with toys she cares little about. When I ask her about her toys it is very clear that all of the joy she feels from playing with her toys comes only from her top 3 toys whilst the rest are just there to make up the numbers.
There’s a great lesson in portfolio management right there – only invest in your highest conviction ideas as you’ll only be diluting the portfolio if you diversify too much. The portfolio currently comprises only c.20 of our highest conviction stocks, and it is a constant evaluation exercise to ensure we are only investing in our highest conviction ideas.
Homework: Look at your portfolio of investments and ask yourself whether you are only invested in your top conviction ideas. Or are you diluting your portfolio with some lower conviction ideas?
Sometimes it is worthwhile to put the text-books away so we can learn from the best.
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